The flat tax in the old Soviet bloc

Recent data from the Department of Commerce suggests that tax evasion has risen since 1999. Annually, it publishes data comparing adjusted gross income paid by governments and businesses (wages, pensions, interest, dividends, etc.) with the amount reported by individuals on their tax returns. The gap between these two figures is the best measure we have of tax evasion.

In 2002, the latest year for which there is data, there was almost $1 trillion paid out that was not reported by individuals. If all this income were taxed at the average individual income tax rate of 14 percent that year, the federal government would have collected an additional $135 billion. And this is a low estimate, since much of the income not reported was undoubtedly by people in brackets well above 14 percent.

More worrisome is the rise in the tax gap to 13.7 percent in 2002 -- the difference between the IRS and Commerce income measures as a share of the Commerce figure. This is the largest figure recorded since data began being kept in 1959. It was only 10.7 percent in 2000. The AGI gap averaged 11.4 percent in the 1990s and 11.9 percent in the 1980s.

The flat tax is not a cure-all for tax evasion, but as the Russian example shows, it can help a lot. When people perceive that the tax system is fundamentally unfair, because everyone appears to be paying different tax rates despite having similar incomes, it diminishes any guilt taxpayers may feel about underpaying their taxes.

Too often in Washington, tax fairness is defined solely in terms of what economists call vertical equity -- whether the rich pay more than the poor. But horizontal equity -- treating equals equally -- is much more important for tax compliance. When there is a single tax rate, people are more confident that their neighbors are paying the same tax they are, which boosts compliance.

It also improves compliance because the IRS doesn't need to know as much about the nature and timing of taxpayers' income. Since all income is taxed the same, they have no incentive to convert wages into capital income or shift income from one year to another, for example.

Lastly, it should not be forgotten that a flat tax is the revenue-raising system most compatible with human freedom. As University of Chicago law professor Richard Epstein recently put it, "It is no accident that every strong defender of limited government has gravitated toward the flat tax."

Bruce Bartlett is a former senior fellow with the National Center for Policy Analysis of Dallas, Texas. Bartlett is a prolific author, having published over 900 articles in national publications, and prominent magazines and published four books, including Reaganomics: Supply-Side Economics in Action.

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